June 23, 2018

Regulators gave banks great incentives to smoke around drum barrels marked “empty”, and to stay away from drums marked “full”.

Gillian Tett writes “before 2008 the big banks spent a great deal of time fretting about issues that seemed obviously risky — hedge funds or highly leveraged companies — but tended to ignore anything that seemed safe or boring, such as AAArated mortgage-backed securities” “What the Hopi culture teaches us about risk” June 23.

Sir, if you go to my TeaWithFT blog and click on Gillian Tett, you will find that over the years I must have written her at least 100 letters explaining that what is perceived as risky, drums marked “full”, is never as dangerous than what’s perceived as safe, drums named “empty”. 

But, if a 70 year old paper by US fire-safety inspector Benjamin Lee Whorf, based a lot on Hopi Native American culture, is more convincing to Ms. Tett than my arguments, so be it.

My real complaint though is that Ms. Tett only refers to what bankers did, and does not mention the fact that bank regulators, on top of it all, with their risk weighted capital requirements, allowed banks to smoke (leverage) much more around drums named “empty”, than around drums named “full”. 

So when Ms. Tett writes: “In theory, this danger has now receded: banks have been trained to take a more holistic view of risk and to question whether even AAA ratings are always safe”, let us not forget that with Basel II, regulators allowed bank to leverage a mindboggling 62.5 times if only an AAA to AA rating was present. Since that besserwisser regulatory mentality still prevails, and risk weighting derived incentives still exists, unfortunately I do not share the hope that dangers have receded. New dangerous “absolutely safe” always lurk around the corners.

And Sir, come on, we have European central bankers who told banks “You can smoke as much as you like around that 0% risk weighted drum named Greece”; and they have still not been made accountable for that… and, between you and I, you FT is not entirely without blame for that.

PS. The sad complement to this analysis is that what regulators decreed as drums marked “full”, and made banks stay away from, includes entrepreneurs and SMEs, something which must erode the dynamism of the economy.